'Banking is a very good business unless you do dumb things,' says Wells Fargo's largest shareholder.
Interview by Adam Lashinsky
Last Updated: April 20, 2009: 11:40 AM ET
SAN FRANCISCO (Fortune) -- As the largest shareholder of Wells Fargo through Berkshire Hathaway (BRKB), Warren Buffett knows the San Francisco bank deeply. He first invested before Wells Fargo was bought by Norwest, where current Wells Chairman Dick Kovacevich was CEO. As part of his reporting for his feature on Wells Fargo (WFC, Fortune 500), Fortune Editor at Large Adam Lashinsky spoke at length with Buffett by telephone on March 26.Fortune: How is Wells Fargo unique?Warren Buffett: It's sort of hard to imagine a business that large being unique. You'd think they'd need to be like any other bank by the time they got to that size. Those guys have gone their own way. That doesn't mean that everything they've done has been right. But they've never felt compelled to do anything because other banks were doing it, and that's how banks get in trouble, when they say, "Everybody else is doing it, why shouldn't I?"
Bilibala => it is hard to not doing when everyone is doing it.What about all the smart analysts who think no big bank can survive in its present form, including Wells Fargo?Almost 20 years ago they were saying the same thing. In the end banking is a very good business unless you do dumb things. You get your money extraordinarily cheap and you don't have to do dumb things. But periodically banks do it, and they do it as a flock, like international loans in the 80s. You don't have to be a rocket scientist when your raw material cost is less than 1-1/2%. So I know that you can have a model that works fine and Wells has come closer to doing that right than any other big bank by some margin. They get their money cheaper than anybody else. We're the low-cost producer at Geico in auto insurance among big companies. And when you're the low-cost producer - whether it's copper, or in banking - it's huge.
Then on top of that, they're smart on the asset size. They stayed out of most of the big trouble areas. Now, even if you're getting 20% down payments on houses, if the other guy did enough dumb things, the house prices can fall to where you get hurt some. But they were not out there doing option ARMs and all these crazy things. They're going to have plenty of credit losses. But they will have, after a couple of quarters of getting Wachovia the way want it, $40 billion of pre-provision income.
And they do not have all kinds of time bombs around. Wells will lose some money. There's no question about that. And they'll lose more than the normal amount of money. Now, if they were getting their money at a percentage point higher, that would be $10 billion of difference there. But they've got the secret to both growth, low-cost deposits and a lot of ancillary income coming in from their customer base.
Bilibala => most of analysts are accurate in short term, especially the one concern about risk management. You can't tell people it is not risky at all "if" you look at things in long term. But for investors, if you look for long term, those analysts works are irrelevant to you.Insurance revenues for example, which had double-digit revenue growth in 2008.And I would say that most of the critics of Wells don't even know they've got that business. That business alone is worth many billions of dollars. And their mortgage business, as you can imagine in this period, I mean, the volume that is poring through there, is huge. The critics have been right on other big banks, so I think they're inclined to sweep Wells in as well to some extent. And if you've been right on Citi and you've been right on BofA, it gets easy to say, well, they're all going to go.
We own stock in four banks: USB, Wells, M&T, and SunTrust. SunTrust I don't know about because South Florida is going to be the last to come back, and they've got a concentration down there. The other three, they're going to have a lousy year, but they'll come out of it with far more earnings power. The deposits are flowing in. The spreads are wide. It's a helluva good business.
Bilibala => among the four, I only have Wells Fargo. Mainly because of Warren Buffet, and also because it has the highest interest margin, an interest margin away higher than peers.Dick Kovacevich specifically told me to ask you your views on tangible common equity.What I pay attention to is earning power. Coca-Cola has no tangible common equity. But they've got huge earning power. And Wells ... you can't take away Wells' customer base. It grows quarter by quarter. And what you make money off of is customers. And you make money on customers by having a helluva spread on assets and not doing anything really dumb. And that's what they do.
Incidentally, they won't lend Berkshire money. They're not interested in national credits or any of that stuff where the spreads are narrow. We did a big deal about six or seven years ago on Finova, which we did jointly with Leucadia. And what was then the old First National of Boston sort of headed the deal up, and people would come in for $500 million or $200 million. Wells wasn't interested. There wasn't enough money in it, basically. I got a big kick out of that because that was exactly how they should think. Everybody else wanted to be in it, and they were doing it for 20 basis points or something of the sort. And they'd make commitments for all kinds of credit for 6 or 8 basis points, and the ones that were in the underwriting business, they would do it just get the underwriting.
Bilibala => don't waste time to do things without reasonable reward, earthly or heavenly, I guess that also whole ture.But back to tangible common equity...You don't make money on tangible common equity. You make money on the funds that people give you and the difference between the cost of those funds and what you lend them out on. And that's where people get all mixed up incidentally on things like the TARP. They say, 'Well, where'd the 5 billion go or where'd the 10 billion go that was put in?' That isn't what you make money on. You make money on that deposit base of $800 billion that they've got now. And that deposit base I guarantee you will cost Wells a lot less than it cost Wachovia. And they'll put out the money differently.
They'll have to work through a lot of this stuff that they inherited from Wachovia. Those option ARMs, they explained exactly how they break them down, and in the end they may lose 3 or 4 billion more. Nobody knows exactly. But I would say that California residential real estate is not deteriorating. It hasn't moved up. But it has flattened out with good volume recently. So my guess is that the option ARMs will work out about as they guessed.
Bilibala => tangible common equity / tangible assets (as well as the total assets / total common shareholders' equity) becomes a popular ratio for risk management. Analysts use them to judge whether a bank has sufficient money to cover its assets in case if any write down in near future. It is conservative, and in most of the time, if someone based on these 2 ratios and ignore the rest, it will be over-conservative and over emphasis on risk. What if the Treasury imposes new capital requirements? Will it hamper their earnings power?I don't think it'll hamper their earnings. But if you make them sell a lot of common equity it would kill the common shareholder. It wouldn't increase the earning power in the future, and it would increase the shares outstanding. Wells, if they want another $10 billion in common equity or something like that in Wells, they'll have it in a very short period of time at this dividend rate. [In March, Wells cut its dividend by 85%.] Wells will be piling up the equity while they're paying nominal dividends. They could afford to pay the old dividend. But since they won't be paying the old dividend, that's $4 billion a year or something that they'll be adding to equity.
I would have been fine if they had just said, 'Look it, we'll quit paying any common dividend until our equity has gone up by whatever it might be, 10 or 15 billion.' And they'd get there in no time. Then they could pay the regular dividend. They elected to do it this other way because everybody seems to be kind of doing it. The idea of forgoing all or most of the dividend for a year to build the common equity ratio up, if that's what the government wants, that's fine. But that isn't really the key to the future of Wells, unless the regulators make it the key to the future of Wells. The key to the future of Wells is continuing to get the money in at very low costs, selling all kinds of services to their customer and having spreads like nobody else has.
Bilibala => increase capital won't help the bank to increase earning, it will only give certain comfront and confidence to the general investors the the government is doing something and fully support the entire banking system.How is Wells differentiated from the banks you own and the ones you don't?Wells just has a whole different attitude. That's why Kovacevich calls them retail stores. He doesn't even like the word banking. I mean, he is looking to have a maximum enduring relationship with many, many millions of people. Tens of millions. And at the base of it involves getting money in very cheap. When you do that that's a helluva start in the business. The difference between getting your money at 1-1/2 % and 2-1/2% on a trillion-dollar asset base is $10 billion a year. It's hard to overemphasize that. He thinks more like Sam Walton than he thinks like J.P. Morgan. I'm talking about the individual there. He's a retailer. He's not trying to influence Washington or be the most important guy on the scene or anything like that. He's just trying to do business with millions of people every day and make a few bucks off of them.
Bilibala => how can Wells Fargo borrow low and re-borrow high? How can Wells Fargo pay less to the depositers and earn more on mortgagers? How can its net interest margin 1-2% higher than peers? I don't know. All I know is: it is an awesome bank that able to earn more $$ in every single dollar of assets.
Now that you mention it, Kovacevich has done a pretty good job of annoying Washington, wouldn't you say?That's hard to tell. There's an advantage to being that way too. He's not going to cozy up or be sycophantic toward his regulator, and I would say most bankers probably are now. They need to be. But his strong point is retailing not diplomacy. I kind of like that. It's hard for a guy that knows his institution forward and backwards to have somebody come in that really may be working off a check list or something and is telling him what to do. And I'm sure that Dick gets antagonized by that sometimes. In the end, he's got the record. And he's got the business to back up what he's doing.
To the extent that his tangible common equity is low, a) nobody was even talking about that a year ago. And b) they should be talking about earning power. But it comes about in part because he saved the FDIC's bacon on Wachovia. I mean they had a deal on Citigroup (
C,
Fortune 500) that had big assistance involved in it, and the FDIC moved about what would have been about 5% of the deposits in the United States without a dime of expense to the taxpayer or the FDIC to Wells. And Wells took it over. And if they'd gone to Citigroup a) they would have looked like idiots, and within a very short period considering what happened to Citi. So to penalize them because they solved the FDIC's problem without cost to the FDIC would be a little crazy. And I imagine that's what gets Dick a little riled up.
Bilibala => yes, FDIC now cost less & bear less to safe Wachovia. At the same time, Wachovia significant strengthen Wells Fargo's asset base, customer base and deposit base.So what is your metric for valuing a bank?It's earnings on assets, as long as they're being achieved in a conservative way. But you can't say earnings on assets, because you'll get some guy who's taking all kinds of risks and will look terrific for a while. And you can have off-balance sheet stuff that contributes to earnings but doesn't show up in the assets denominator. So it has to be an intelligent view of the quality of the earnings on assets as well as the quantity of the earnings on assets. But if you're doing it in a sound way, that's what I look at.
Bilibala => that's a good insight about investment in bank.How confident will you be in Wells when Kovacevich retires?Well, John [Stumpf] is in charge. Dick is a terrific help to John. I play bridge with John on the Internet. He plays under the name of HTUR. His wife's name is Ruth. My bridge partner, who I probably play bridge with four times a week, developed online banking for Wells. A woman named Sharon Osberg. And she's worked with those people. And she told me about John Stumpf ten years ago. I've had some insight through her on these people. But the real insight you get about a banker is how they bank. You've got to see what they do and what they don't do. Their speeches don't make any difference. It's what they do and what they don't do. And what Wells didn't do is what defines their greatness.
Bilibala => should be fine, Wells Fargo's corp culture will not change. I like its conservative way to do business.How is John's bridge game?John is a very good bridge player. But he doesn't play as much as I do. I play all the time. He's smart. He's a different personality than Dick. Dick is a real sales person. They both subscribe to the same principles of banking. They just don't think you have to do things that the other guy is doing.
First Published: April 20, 2009: 6:13 AM ET
